AP Macroeconomics Question 365: Answer and Explanation
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12. The economy is currently operating at full employment. Assuming flexible wages and prices, how would a decline in aggregate demand affect GDP and the price level in the short run, and GDP and the price level in the long run?
SHORT-RUN GDP SHORT-RUN PRICE LEVEL LONG-RUN GDP LONG-RUN PRICE LEVEL
- A. Falls Falls No change Falls
- B. Falls Falls Falls Falls
- C. No change Falls No change No change
- D. Falls Falls No change No change
- E. Falls Falls Falls Falls
Correct Answer: A
A-If prices and wages are flexible, the long-run economy readjusts to full employment. Falling AD lowers the price level and real GDP in the short run, but eventually lower wages shift the short-run AS curve to the right, further lowering the price level and moving long-run production back to full employment.